How A Congress-Sanctioned Tax Credit Rescued Q1 Earnings

Tyler Durden's picture

A 25-year-old research-and-development tax credit that was extended by Congress - following its expiration at the end of 2011 - lifted profits for many firms in the S&P 500 by over 10%. While top-line revenue growth was a damp squib, earnings grew a more robust 6.7% thanks, as the WSJ notes, in large part to this tax-credit's 'accounting' gains. This stock-market-saving tax-gimmick, however, is only for "big corporate America," since, "small firms aren't profitable enough to get the credit." Looking ahead, however, the unusual benefit from extension of the tax credit won't help corporate profits for the rest of this year as it is set to expire at the end of this year (having cost the taxpayer over $7 billion).

Via The Wall Street Journal,

Strong first-quarter corporate profits may not be quite as good as they look.

 

An analysis by The Wall Street Journal shows that the extension of a big tax credit quietly boosted the profits of dozens of companies. Under accounting rules, the companies reported a year's worth of benefits from the research-and-development tax credit in their first-quarter results, lifting profits for many of them by more than 10%.

 

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...the S&P-500 companies also set aside 5.6% less money for taxes, and that helped their cumulative profits grow a robust 6.7%, the Journal found.

 

The biggest reason they took that action: the extension of the research credit and other tax breaks in January.

 

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The following tables gives some idea of the order of magnitude savings

 

[Intel] said the "substantial majority" of the decline stemmed from extension of the research credit. If Intel's profits had been taxed at last year's rate, it would have set aside an additional $290 million.

 

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The previous extension expired at the end of 2011, meaning that companies couldn't claim the credit last year. That quietly increased tax rates—and hurt earnings—last year. Under the measure approved in January, the research credit will again expire at the end of this year, raising the prospect of future distortions in corporate earnings.

 

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"It's big corporate America," Ms. Rao said of the beneficiaries. "Small firms aren't profitable enough to get the credit."

 

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It's unclear how well investors anticipated the additional tax benefits.

 

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Looking ahead, the unusual benefit from extension of the tax credit won't help corporate profits for the rest of this year. "The effective tax rate we saw in the first quarter is not representative of what we'll see in the rest of the year,"